Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 2016


OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to _________

Commission file number 1-11406

KADANT INC.
(Exact name of registrant as specified in its charter)

Delaware
 
52-1762325
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
 
 
One Technology Park Drive
 
 
Westford, Massachusetts
 
01886
(Address of Principal Executive Offices)
 
(Zip Code)

Registrant's telephone number, including area code: (978) 776-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
  Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨    No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
 
Outstanding at July 29, 2016
Common Stock, $.01 par value
 
10,897,252



PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)

Assets

 
 
July 2,
2016
 
January 2,
2016
(In thousands)
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
54,211

 
$
65,530

Restricted cash (Note 1)
 
706

 
1,406

Accounts receivable, less allowances of $2,427 and $2,163 (Note 1)
 
65,897

 
64,321

Inventories (Note 1)
 
63,464

 
56,758

Unbilled contract costs and fees
 
5,776

 
6,580

Other current assets
 
11,423

 
10,525

Total Current Assets
 
201,477

 
205,120

 
 
 
 
 
Property, Plant, and Equipment, at Cost
 
126,405

 
118,014

Less: accumulated depreciation and amortization
 
77,466

 
75,721

 
 
48,939

 
42,293

 
 
 
 
 
Other Assets
 
14,309

 
11,002

 
 
 
 
 
Intangible Assets, Net (Note 1)
 
58,584

 
38,032

 
 
 
 
 
Goodwill (Note 1)
 
157,473

 
119,051

 
 
 
 
 
Total Assets
 
$
480,782

 
$
415,498


The accompanying notes are an integral part of these condensed consolidated financial statements.

2


KADANT INC.
Condensed Consolidated Balance Sheet (continued)
(Unaudited)

Liabilities and Stockholders' Equity

 
 
July 2,
2016
 
January 2,
2016
(In thousands, except share amounts)
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
Short-term obligations and current maturities of long-term obligations (Note 6)
 
$
3,109

 
$
5,250

Accounts payable
 
30,828

 
24,418

Customer deposits
 
24,340

 
20,123

Accrued payroll and employee benefits
 
16,960

 
19,583

Accrued income taxes
 
2,497

 
5,333

Other current liabilities
 
20,161

 
21,921

Total Current Liabilities
 
97,895

 
96,628

 
 
 
 
 
Long-Term Deferred Income Taxes
 
18,381

 
8,992

 
 
 
 
 
Other Long-Term Liabilities
 
22,089

 
15,933

 
 
 
 
 
Long-Term Obligations (Note 6)
 
61,206

 
26,000

 
 
 
 
 
Commitments and Contingencies (Note 13)
 
—

 
—

 
 
 
 
 
Stockholders' Equity:
 
 

 
 

Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued
 
—

 
—

Common stock, $.01 par value, 150,000,000 shares authorized; 14,624,159 shares issued
 
146

 
146

Capital in excess of par value
 
99,045

 
100,536

Retained earnings
 
308,312

 
297,258

Treasury stock at cost, 3,726,907 and 3,850,779 shares
 
(91,324
)
 
(94,359
)
Accumulated other comprehensive items (Note 9)
 
(36,570
)
 
(36,972
)
Total Kadant Stockholders' Equity
 
279,609

 
266,609

Noncontrolling interest
 
1,602

 
1,336

Total Stockholders' Equity
 
281,211

 
267,945

 
 
 
 
 
Total Liabilities and Stockholders' Equity
 
$
480,782

 
$
415,498


The accompanying notes are an integral part of these condensed consolidated financial statements.

3


KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
 
 
Three Months Ended
 
 
July 2,
2016
 
July 4,
2015
(In thousands, except per share amounts)
 
 
 
 
 
 
 
Revenues (Note 12)
 
$
111,828

 
$
98,327

 
 
 
 
 
Costs and Operating Expenses:
 
 

 
 

Cost of revenues
 
61,567

 
52,600

Selling, general, and administrative expenses
 
36,072

 
31,068

Research and development expenses
 
1,945

 
1,800

Restructuring costs
 
—

 
216

 
 
99,584

 
85,684

 
 
 
 
 
Operating Income
 
12,244

 
12,643

 
 
 
 
 
Interest Income
 
66

 
43

Interest Expense
 
(340
)
 
(231
)
 
 
 
 
 
Income from Continuing Operations Before Provision for Income Taxes
 
11,970

 
12,455

Provision for Income Taxes
 
3,531

 
3,914

 
 
 
 
 
Income from Continuing Operations
 
8,439

 
8,541

Loss from Discontinued Operation (net of income tax benefit of $3)
 
—

 
(5
)
 
 
 
 
 
Net Income
 
8,439

 
8,536

 
 
 
 
 
Net Income Attributable to Noncontrolling Interest
 
(128
)
 
(72
)
 
 
 
 
 
Net Income Attributable to Kadant
 
$
8,311

 
$
8,464

 
 
 
 
 
Amounts Attributable to Kadant:
 
 

 
 

Income from Continuing Operations
 
$
8,311

 
$
8,469

Loss from Discontinued Operation
 
—

 
(5
)
Net Income Attributable to Kadant
 
$
8,311

 
$
8,464

 
 
 
 
 
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
 
 

 
 

Basic
 
$
0.76

 
$
0.77

Diluted
 
$
0.75

 
$
0.76

 
 
 
 
 
Earnings per Share Attributable to Kadant (Note 4):
 
 

 
 

Basic
 
$
0.76

 
$
0.77

Diluted
 
$
0.75

 
$
0.76

 
 
 
 
 
Weighted Average Shares (Note 4):
 
 

 
 

Basic
 
10,870

 
10,948

Diluted
 
11,152

 
11,173

 
 
 
 
 
Cash Dividend Declared per Common Share
 
$
0.19

 
$
0.17


The accompanying notes are an integral part of these condensed consolidated financial statements.





4


KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
 
 
 
 
 
 
 
Six Months Ended
 
 
July 2,
2016
 
July 4,
2015
(In thousands, except per share amounts)
 
 
 
 
 
 
 
Revenues (Note 12)
 
$
208,366

 
$
190,578

 
 
 
 
 
Costs and Operating Expenses:
 
 

 
 

Cost of revenues
 
114,129

 
100,514

Selling, general, and administrative expenses
 
68,568

 
63,290

Research and development expenses
 
3,649

 
3,460

Restructuring costs and other income (Note 3)
 
(317
)
 
300

 
 
186,029

 
167,564

 
 
 
 
 
Operating Income
 
22,337

 
23,014

 
 
 
 
 
Interest Income
 
121

 
96

Interest Expense
 
(609
)
 
(462
)
 
 
 
 
 
Income from Continuing Operations Before Provision for Income Taxes
 
21,849

 
22,648

Provision for Income Taxes (Note 5)
 
6,419

 
7,182

 
 
 
 
 
Income from Continuing Operations
 
15,430

 
15,466

Income from Discontinued Operation (net of income tax provision of $38)
 
—

 
60

 
 
 
 
 
Net Income
 
15,430

 
15,526

 
 
 
 
 
Net Income Attributable to Noncontrolling Interest
 
(243
)
 
(165
)
 
 
 
 
 
Net Income Attributable to Kadant
 
$
15,187

 
$
15,361

 
 
 
 
 
Amounts Attributable to Kadant:
 
 

 
 

Income from Continuing Operations
 
$
15,187

 
$
15,301

Income from Discontinued Operation
 
—

 
60

Net Income Attributable to Kadant
 
$
15,187

 
$
15,361

 
 
 
 
 
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
 
 

 
 

Basic
 
$
1.40

 
$
1.40

Diluted
 
$
1.37

 
$
1.37

 
 
 
 
 
Earnings per Share Attributable to Kadant (Note 4):
 
 

 
 

Basic
 
$
1.40

 
$
1.41

Diluted
 
$
1.37

 
$
1.38

 
 
 
 
 
Weighted Average Shares (Note 4):
 
 

 
 

Basic
 
10,831

 
10,920

Diluted
 
11,085

 
11,130

 
 
 
 
 
Cash Dividends Declared per Common Share
 
$
0.38

 
$
0.34


The accompanying notes are an integral part of these condensed consolidated financial statements.


5


KADANT INC.
Condensed Consolidated Statement of Comprehensive Income
(Unaudited)

 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Income
 
$
8,439

 
$
8,536

 
$
15,430

 
$
15,526

 
 
 
 
 
 
 
 
 
Other Comprehensive Items:
 
 

 
 

 
 

 
 

Foreign currency translation adjustment
 
(5,194
)
 
2,264

 
736

 
(9,838
)
Pension and other post-retirement liability adjustments (net of tax provision (benefit) of $77 and $(159) in the three and six months ended July 2, 2016, respectively, and $63 and $155 in the three and six months ended July 4, 2015, respectively)
 
147

 
115

 
(271
)
 
288

Deferred gain (loss) on hedging instruments (net of tax (benefit) provision of $(151) and $(223) in the three and six months ended July 2, 2016, respectively, and $61 and $78 in the three and six months ended July 4, 2015, respectively)
 
86

 
428

 
(40
)
 
(80
)
Other Comprehensive Items
 
(4,961
)
 
2,807

 
425

 
(9,630
)
Comprehensive Income
 
3,478

 
11,343

 
15,855

 
5,896

Comprehensive Income Attributable to Noncontrolling Interest
 
(92
)
 
(98
)
 
(266
)
 
(59
)
Comprehensive Income Attributable to Kadant
 
$
3,386

 
$
11,245

 
$
15,589

 
$
5,837


The accompanying notes are an integral part of these condensed consolidated financial statements.

6


KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
 
 
Six Months Ended
 
 
July 2,
2016
 
July 4,
2015
(In thousands)
 
 
 
 
 
 
 
Operating Activities:
 
 
 
 
Net income attributable to Kadant
 
$
15,187

 
$
15,361

Net income attributable to noncontrolling interest
 
243

 
165

Income from discontinued operation
 
—

 
(60
)
Income from continuing operations
 
15,430

 
15,466

Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
7,477

 
5,663

Stock-based compensation expense
 
2,596

 
3,241

Tax benefits from stock-based compensation awards
 
—

 
(884
)
Provision for losses on accounts receivable
 
320

 
219

Gain on the sale of property, plant, and equipment
 
(350
)
 
(3
)
Other items, net
 
289

 
(324
)
Contributions to pension plan
 
(540
)
 
(540
)
Changes in current assets and liabilities, net of effects of acquisition:
 
 

 
 

Accounts receivable
 
3,699

 
(1,988
)
Unbilled contract costs and fees
 
818

 
1,040

Inventories
 
(2,498
)
 
(10,843
)
Other current assets
 
459

 
(2,427
)
Accounts payable
 
172

 
2,000

Other current liabilities
 
(8,663
)
 
1,520

Net cash provided by continuing operations
 
19,209

 
12,140

Net cash used in discontinued operation
 
—

 
(39
)
Net cash provided by operating activities
 
19,209

 
12,101

 
 
 
 
 
Investing Activities:
 
 

 
 

Acquisition, net of cash acquired
 
(56,617
)
 
—

Purchases of property, plant, and equipment
 
(1,736
)
 
(2,651
)
Proceeds from sale of property, plant, and equipment
 
399

 
28

Net cash used in investing activities
 
(57,954
)
 
(2,623
)
 
 
 
 
 
Financing Activities:
 
 

 
 

Proceeds from issuance of long-term obligations
 
46,046

 
15,000

Repayments of short-and long-term obligations
 
(12,250
)
 
(12,361
)
Purchases of Company common stock
 
—

 
(4,040
)
Dividends paid
 
(3,894
)
 
(3,494
)
Tax withholding payments related to stock-based compensation
 
(2,435
)
 
(2,499
)
Payment of contingent consideration
 
(1,091
)
 
—

Proceeds from issuance of Company common stock
 
1,374

 
285

Tax benefits from stock-based compensation awards
 
—

 
884

Change in restricted cash
 
724

 
(842
)
Net cash provided by (used in) financing activities
 
28,474

 
(7,067
)
 
 
 
 
 
Exchange Rate Effect on Cash and Cash Equivalents
 
(1,048
)
 
(427
)
 
 
 
 
 
(Decrease) Increase in Cash and Cash Equivalents
 
(11,319
)
 
1,984

Cash and Cash Equivalents at Beginning of Period
 
65,530

 
45,378

Cash and Cash Equivalents at End of Period
 
$
54,211

 
$
47,362

See Note 1 for supplemental cash flow information.
The accompanying notes are an integral part of these condensed consolidated financial statements.

7


KADANT INC.
Condensed Consolidated Statement of Stockholders' Equity
(Unaudited)

(In thousands, except share amounts)
 
Common
Stock
 
Capital in
Excess of Par Value
 
Retained Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive Items
 
Noncontrolling Interest
 
Total
Stockholders' Equity
 
Shares
 
Amount
 
 
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 3, 2015
 
14,624,159

 
$
146

 
$
98,769

 
$
270,249

 
3,760,019

 
$
(87,727
)
 
$
(17,146
)
 
$
1,168

 
$
265,459

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Net income
 
—

 
—

 
—

 
15,361

 
—

 
—

 
—

 
165

 
15,526

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Dividends declared
 
—

 
—

 
—

 
(3,716
)
 
—

 
—

 
—

 
—

 
(3,716
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Activity under stock plans
 
—

 
—

 
(1,505
)
 
—

 
(115,427
)
 
2,697

 
—

 
—

 
1,192

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Tax benefits related to employees' and directors' stock plans
 
—

 
—

 
884

 
—

 
—

 
—

 
—

 
—

 
884

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Purchases of Company common stock
 
—

 
—

 
—

 
—

 
86,518

 
(4,040
)
 
—

 
—

 
(4,040
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Other comprehensive items
 
—

 
—

 
—

 
—

 
—

 
—

 
(9,524
)
 
(106
)
 
(9,630
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at July 4, 2015
 
14,624,159

 
$
146

 
$
98,148

 
$
281,894

 
3,731,110

 
$
(89,070
)
 
$
(26,670
)
 
$
1,227

 
$
265,675

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 2, 2016
 
14,624,159

 
$
146

 
$
100,536

 
$
297,258

 
3,850,779

 
$
(94,359
)
 
$
(36,972
)
 
$
1,336

 
$
267,945

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Net income
 
—

 
—

 
—

 
15,187

 
—

 
—

 
—

 
243

 
15,430

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Dividends declared
 
—

 
—

 
—

 
(4,133
)
 
—

 
—

 
—

 
—

 
(4,133
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Activity under stock plans
 
—

 
—

 
(1,491
)
 
—

 
(123,872
)
 
3,035

 
—

 
—

 
1,544

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Other comprehensive items
 
—

 
—

 
—

 
—

 
—

 
—

 
402

 
23

 
425

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at July 2, 2016
 
14,624,159

 
$
146

 
$
99,045

 
$
308,312

 
3,726,907

 
$
(91,324
)
 
$
(36,570
)
 
$
1,602

 
$
281,211


The accompanying notes are an integral part of these condensed consolidated financial statements.

8

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)




1
1.    Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations
Kadant Inc. (collectively, "we," "Kadant," "the Company," or "the Registrant") was incorporated in Delaware in November 1991 and currently trades on the New York Stock Exchange under the ticker symbol "KAI."

The Company and its subsidiaries' continuing operations include two reportable operating segments, Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products.

Through its Papermaking Systems segment, the Company develops, manufactures, and markets a range of equipment and products primarily for the global papermaking, paper recycling, recycling and waste management, and other process industries. The Company's principal products in this segment include custom-engineered stock-preparation systems and equipment for the preparation of wastepaper for conversion into recycled paper and balers and related equipment used in the processing of recyclable and waste materials; fluid-handling systems used primarily in the dryer section of the papermaking process and during the production of corrugated boxboard, metals, plastics, rubber, textiles, chemicals, and food; doctoring systems and equipment and related consumables important to the efficient operation of paper machines; and cleaning and filtration systems essential for draining, purifying, and recycling process water and cleaning paper machine fabrics and rolls.

Through its Wood Processing Systems segment, the Company designs and manufactures stranders and related equipment used in the production of oriented strand board (OSB), an engineered wood panel product used primarily in home construction. This segment also supplies debarking and wood chipping equipment used in the forest products and the pulp and paper industries, and provides refurbishment and repair of pulping equipment for the pulp and paper industry.

Through its Fiber-based Products business, the Company manufactures and sells granules derived from papermaking byproducts primarily for use as agricultural carriers and for home lawn and garden applications, as well as for oil and grease absorption.

Interim Financial Statements
The interim condensed consolidated financial statements and related notes presented have been prepared by the Company, are unaudited, and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of the Company's financial position at July 2, 2016 and its results of operations, comprehensive income, cash flows, and stockholders' equity for the three and six month periods ended July 2, 2016 and July 4, 2015. Interim results are not necessarily indicative of results for a full year or for any other interim period.

The condensed consolidated balance sheet presented as of January 2, 2016 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 2016. The condensed consolidated financial statements and related notes are presented as permitted by the Securities and Exchange Commission (SEC) rules and regulations for Form 10-Q and do not contain certain information included in the annual consolidated financial statements and related notes of the Company. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 2016, filed with the SEC.

Financial Statement Presentation
Certain reclassifications have been made to prior periods to conform with current reporting. As a result of the adoption of the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2016-09, "Improvements to Employee Share-Based Payment Arrangements," tax withholding payments made related to stock-based compensation awards have been reclassified from other current liabilities within operating activities in the condensed consolidated statement of cash flows and presented separately within financing activities in the 2015 period.

Critical Accounting Policies
Critical accounting policies are defined as those that entail significant judgments and estimates, and could potentially result in materially different results under different assumptions and conditions. The Company believes that the most critical accounting policies upon which its financial position depends, and which involve the most complex or subjective decisions or assessments, concern revenue recognition and accounts receivable, warranty obligations, income taxes, the valuation of

9

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)

goodwill and intangible assets, inventories and pension obligations. Discussions of the application of these and other accounting policies are included in Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 2016.

Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.

Although the Company makes every effort to ensure the accuracy of the estimates and assumptions used in the preparation of its condensed consolidated financial statements or in the application of accounting policies, if business conditions were different, or if the Company were to use different estimates and assumptions, it is possible that materially different amounts could be reported in the Company's condensed consolidated financial statements.

Supplemental Cash Flow Information
 
 
Six Months Ended
(In thousands)
 
July 2,
2016
 
July 4,
2015
Non-Cash Investing Activities:
 
 
 
 
Fair value of assets acquired
 
$
86,555

 
$
—

Cash paid for acquired business
 
(58,894
)
 
—

Liabilities assumed of acquired business
 
$
27,661

 
$
—

Non-Cash Financing Activities:
 
 

 
 

Issuance of Company common stock
 
$
3,057

 
$
2,967

Dividends declared but unpaid
 
$
2,070

 
$
1,852


Restricted Cash
As of July 2, 2016 and January 2, 2016, the Company had restricted cash of $706,000 and $1,406,000, respectively. This cash serves as collateral for bank guarantees primarily associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business. All of the bank guarantees will expire by the end of 2017.

Banker's Acceptance Drafts
The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for outstanding accounts receivable. The banker's acceptance drafts are non-interest bearing obligations of the issuing bank and mature within six months of the origination date. The Company has the ability to sell the drafts at a discount to a third-party financial institution or transfer the drafts to vendors in settlement of current accounts payable prior to the scheduled maturity date. These drafts, which totaled $7,273,000 and $8,314,000 at July 2, 2016 and January 2, 2016, respectively, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary sells the drafts to a bank and receives a discounted amount, transfers the banker's acceptance drafts in settlement of accounts payable prior to maturity, or obtains cash payment on the scheduled maturity date.


10

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)

Inventories
The components of inventories are as follows:
 
 
July 2,
2016
 
January 2,
2016
(In thousands)
 
 
Raw Materials and Supplies
 
$
23,911

 
$
22,324

Work in Process
 
16,570

 
13,819

Finished Goods
 
22,983

 
20,615

Total Inventories
 
$
63,464

 
$
56,758


Intangible Assets, Net
Acquired intangible assets are as follows:
 
 
July 2,
2016
 
January 2,
2016
(In thousands)
 
 
Indefinite-Lived Intangible Asset
 
$
8,100

 
$
8,100

 
 
 
 
 
Definite-Lived Intangible Assets, Gross
 
$
77,052

 
$
77,052

Acquisition
 
24,623

 
—

Accumulated amortization
 
(45,373
)
 
(40,908
)
Currency translation
 
(5,818
)
 
(6,212
)
Definite-Lived Intangible Assets, Net
 
$
50,484

 
$
29,932

 
 
 
 
 
Total Intangible Assets, Net
 
$
58,584

 
$
38,032


Goodwill
The changes in the carrying amount of goodwill by segment are as follows:
(In thousands)
 
Papermaking Systems Segment
 
Wood Processing Systems Segment
 
Total
Balance at January 2, 2016
 
 
 
 
 
 
Gross balance
 
$
187,720

 
$
16,840

 
$
204,560

Accumulated impairment losses
 
(85,509
)
 
—

 
(85,509
)
Net balance
 
102,211

 
16,840

 
119,051

Acquisition
 
38,344

 
—

 
38,344

Currency Translation
 
(1,109
)
 
1,187

 
78

Total 2016 Adjustments
 
37,235

 
1,187

 
38,422

Balance at July 2, 2016
 
 

 
 

 
 

Gross balance
 
224,955

 
18,027

 
242,982

Accumulated impairment losses
 
(85,509
)
 
—

 
(85,509
)
Net balance
 
$
139,446

 
$
18,027

 
$
157,473


Warranty Obligations
The Company provides for the estimated cost of product warranties at the time of sale based on the actual historical occurrence rates and repair costs, as well as knowledge of any specific warranty problems that indicate that projected warranty costs may vary from historical patterns. The Company typically negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications. While the Company engages in extensive product quality programs and processes, the Company's warranty obligation is affected by product failure rates, repair costs, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to the Company. Should actual product failure rates,

11

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)

repair costs, service delivery costs, or supplier warranties on parts differ from the Company's estimates, revisions to the estimated warranty liability would be required.

The changes in the carrying amount of accrued warranty costs included in other current liabilities in the accompanying condensed consolidated balance sheet are as follows:
 
 
Six Months Ended
(In thousands)
 
July 2,
2016
 
July 4,
2015
Balance at Beginning of Period
 
$
3,670

 
$
3,875

Provision charged to income
 
1,524

 
917

Usage
 
(1,623
)
 
(1,252
)
Acquisition
 
991

 
—

Currency translation
 
(20
)
 
(153
)
Balance at End of Period
 
$
4,542

 
$
3,387


Recent Accounting Pronouncements
Revenue from Contracts with Customers (Topic 606) Section A-Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40). In May 2014, the FASB issued ASU No. 2014-09, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. In March 2016, the FASB issued ASU No. 2016-08, which further clarifies the guidance on the principal versus agent considerations within ASU No. 2014-09. In April 2016, the FASB issued ASU No. 2016-10 to expand the guidance on identifying performance obligations and licensing within ASU 2014-09. In May 2016, the FASB issued ASU No. 2016-11, which rescinds certain previously issued guidance, including, among other items, guidance relating to accounting for shipping and handling fees and freight services effective upon adoption of ASU No. 2014-09. Also in May 2016, the FASB issued ASU No. 2016-12, which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. These new ASUs are effective for the Company beginning in fiscal 2018. Early adoption is permitted in fiscal 2017. The guidance permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect that these ASUs will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

Compensation-Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. In June 2014, the FASB issued ASU No. 2014-12, which clarifies the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. Under the new guidance, a performance target that affects vesting and could be achieved after completion of the service period should be treated as a performance condition under FASB Accounting Standards Codification (ASC) 718 and, as a result, should not be included in the estimation of the grant-date fair value of the award. An entity should recognize compensation cost for the award when it becomes probable that the performance target will be achieved. In the event that an entity determines that it is probable that a performance target will be achieved before the end of the service period, the compensation cost of the award should be recognized prospectively over the remaining service period. The Company adopted this guidance at the beginning of fiscal 2016. The adoption of this ASU did not have an impact on the Company’s condensed consolidated financial statements.

Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. In April 2015, the FASB issued ASU No. 2015-03, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In addition, in June 2015, the FASB issued ASU No. 2015-15, which allows an entity to defer the requirements of ASU No. 2015-03 on deferred issuance costs related to line-of-credit arrangements. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in these ASUs. These new disclosure items are effective for the Company beginning in fiscal 2016. The Company adopted these ASUs at the beginning of fiscal 2016. Adoption of these ASUs did not have an impact on the Company’s condensed consolidated financial statements.

12

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)

Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). In May 2015, the FASB issued ASU No. 2015-07, which removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. This ASU also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. The Company adopted the disclosure requirements in this guidance at the beginning of fiscal 2016. As this ASU is disclosure-related only, its adoption did not have an effect on the Company’s condensed consolidated financial statements.

Inventory (Topic 330), Simplifying the Measurement of Inventory. In July 2015, the FASB issued ASU No. 2015-11, which requires that an entity measure inventory within the scope of this ASU at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Substantial and unusual losses that result from subsequent measurement of inventory should be disclosed in the financial statements. This new guidance is effective for the Company beginning in fiscal 2017. Early adoption is permitted. The Company is currently evaluating the effect that this ASU will have on its condensed consolidated financial statements.

Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments. In September 2015, the FASB issued ASU No. 2015-16, which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer is required to record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In addition, an entity is required to present, separately on the face of the income statement or through disclosure in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Company adopted this guidance at the beginning of fiscal 2016. Adoption of this ASU did not have an impact on the Company’s condensed consolidated financial statements.
    
Leases (Topic 842). In February 2016, the FASB issued ASU No. 2016-02, which requires a lessee to recognize a right-of-use asset and a lease liability for operating leases, initially measured at the present value of the future lease payments, in its balance sheet. This ASU also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. This new guidance is effective for the Company in fiscal 2019. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.
    
Compensation -Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. In March 2016, the FASB issued ASU No. 2016-09, which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the statement of cash flows. The Company early adopted this ASU at the beginning of fiscal 2016. This ASU requires that excess income tax benefits and tax deficiencies related to stock-based compensation arrangements be recognized as discrete items within the provision for income taxes instead of capital in excess of par value in the reporting period in which they occur. As a result of the adoption of this ASU, the Company recognized an income tax benefit of $191,000, or $0.02 per diluted share, and $396,000, or $0.04 per diluted share, in the Company’s condensed consolidated statement of income in the second quarter and first six months of 2016, respectively. The Company prospectively adopted the requirement to classify the excess tax benefits from stock-compensation awards within operating activities in the condensed consolidated statement of cash flows in the first quarter of 2016. Prior period amounts were not restated. The Company also adopted the guidance in this ASU that requires that taxes paid related to the withholding of common stock upon the vesting of employee stock awards be presented separately within financing activities in the condensed consolidated statement of cash flows. The Company has retrospectively restated the 2015 period to reclassify the comparative amount, which was previously presented in other current liabilities within operating activities. There were no other material effects from adoption of this ASU on the Company’s condensed consolidated financial statements.
    
Financial Instruments -Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU No. 2016-13, which significantly changes the way entities recognize impairment of many financial

13

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)

assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining lives. This new guidance is effective for the Company in fiscal 2020. Early adoption is permitted beginning in fiscal 2019. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.
 
2.    Acquisition

On April 4, 2016, the Company acquired all of the outstanding shares of RT Holding GmbH, the parent corporation of a group of companies known as the PAALGROUP (PAAL) for approximately 49,713,000 euros, net of cash acquired, or approximately $56,617,000. The Company entered into a $29,866,000 euro-denominated borrowing under its unsecured revolving credit facility in the first quarter of 2016 to partially fund the acquisition. The remainder of the purchase price was funded from the Company's internal overseas cash. The Company incurred acquisition transaction costs of approximately $1,665,000 in the first six months of 2016, which were recorded in selling, general, and administrative expenses (SG&A).

PAAL, which is part of the Company's Papermaking Systems segment's Stock-Preparation product line, manufactures balers and related equipment used in the processing of recyclable and waste materials. This acquisition broadened the Company's product portfolio and extended its presence deeper into recycling and waste management. PAAL, headquartered in Germany, also has operations in the United Kingdom, France, and Spain. The Company anticipates several synergies in connection with this acquisition, including expanding sales of the products of the acquired business by leveraging Kadant's geographic presence to enter or further penetrate existing markets as well as sourcing and manufacturing efficiencies.

This acquisition has been accounted for by using the purchase method of accounting and PAAL’s results have been included in the accompanying financial statements from its date of acquisition. The excess of the purchase price for the acquisition of PAAL over the tangible and identifiable intangible assets was recorded as goodwill and amounted to approximately $38,344,000, which is not deductible for tax purposes. The fair values are subject to adjustment upon finalization of the valuation, and therefore the current measurements of intangible assets, acquired goodwill, and assumed assets and liabilities are subject to change.

The following table summarizes the purchase method of accounting for the acquisition of PAAL and the estimated fair values of assets acquired and liabilities assumed:
2016 Acquisition (In thousands)
 
Total
 
 
 
Net Assets Acquired:
 
 
Cash and Cash Equivalents
 
$
2,277

Accounts Receivable
 
5,441

Inventories
 
3,993

Property, Plant, and Equipment
 
7,173

Other Assets
 
4,704

Intangible Assets
 
24,623

Goodwill
 
38,344

Total assets acquired
 
86,555

 
 
 
Accounts Payable
 
5,535

Customer Deposits
 
2,471

Lease Obligations
 
4,222

Long-term Deferred Tax Liability
 
8,128

Other Liabilities
 
7,305

Total liabilities assumed
 
27,661

Net assets acquired
 
$
58,894

 
 
 
Purchase Price:
 
 

Cash
 
$
29,028

Cash Paid to Seller Borrowed Under the Revolving Credit Facility
 
29,866

  Total purchase price
 
$
58,894


14

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

2.    Acquisition (continued)


Definite-lived intangible assets acquired related to the PAAL acquisition included $15,831,000 for customer relationships, $4,203,000 for product technology, $2,278,000 for tradenames, and $2,311,000 for other intangibles. The weighted-average amortization period for definite-lived intangible assets acquired is 12 years, which includes weighted-average amortization periods of 13 years for customer relationships, 9 years for product technology, and 14 years for tradenames.

Pro forma disclosures of the results of operations are not required, as the acquisition is not considered a material business combination as outlined in FASB ASC 805, "Business Combinations."

3.    Restructuring Costs and Other Income

Other Income
In the first six months of 2016, other income consisted of a pre-tax gain of $317,000 from the sale of real estate in Sweden for cash proceeds of $368,000.

Restructuring Costs
In the first six months of 2015, the Company's Papermaking Systems segment recorded restructuring costs of $300,000 for severance costs associated with the reduction of nine employees in Canada and Sweden. These actions were taken to streamline the Company's operations in those locations.

4.    Earnings per Share

Basic and diluted earnings per share (EPS) were calculated as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
(In thousands, except per share amounts)
 
 
 
 
Amounts Attributable to Kadant:
 
 
 
 
 
 
 
 
Income from Continuing Operations
 
$
8,311

 
$
8,469

 
$
15,187

 
$
15,301

(Loss) Income from Discontinued Operation
 
—

 
(5
)
 
—

 
60

Net Income
 
$
8,311

 
$
8,464

 
$
15,187

 
$
15,361

 
 
 
 
 
 
 
 
 
Basic Weighted Average Shares
 
10,870

 
10,948

 
10,831

 
10,920

Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan
 
282

 
225

 
254

 
210

Diluted Weighted Average Shares
 
11,152

 
11,173

 
11,085

 
11,130

 
 
 
 
 
 
 
 
 
Basic Earnings per Share:
 
 

 
 

 
 

 
 

Continuing operations
 
$
0.76

 
$
0.77

 
$
1.40

 
$
1.40

Discontinued operation
 
$
—

 
$
—

 
$
—

 
$
0.01

Net income per basic share
 
$
0.76

 
$
0.77

 
$
1.40

 
$
1.41

 
 
 
 
 
 
 
 
 
Diluted Earnings per Share:
 
 

 
 

 
 

 
 

Continuing operations
 
$
0.75

 
$
0.76

 
$
1.37

 
$
1.37

Discontinued operation
 
$
—

 
$
—

 
$
—

 
$
0.01

Net income per diluted share
 
$
0.75

 
$
0.76

 
$
1.37

 
$
1.38


Unvested restricted stock units (RSUs) equivalent to approximately 41,000 shares of common stock for the second quarter of 2015, and approximately 73,000 and 44,000 shares of common stock for the first six months of 2016 and 2015, respectively, were not included in the computation of diluted EPS because either the effect of their inclusion would have been anti-dilutive, or for unvested performance-based RSUs, the performance conditions had not been met as of the end of the reporting period.


15

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)




5.    Provision for Income Taxes

The provision for income taxes was $6,419,000 and $7,182,000 in the first six months of 2016 and 2015, respectively, and represented 29% and 32% of pre-tax income. The effective tax rate of 29% in the first six months of 2016 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings and the adoption of ASU No. 2016-09 that resulted in a favorable adjustment for the net excess income tax benefits from stock-based compensation arrangements. These items were offset in part by an increase in tax related to non-deductible expenses and state taxes. The effective tax rate of 32% in the first six months of 2015 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings, and was offset in part by an increase in state taxes, tax expense related to an increase in non-deductible expenses, and the U.S. tax cost of foreign operations.

6.    Short- and Long-Term Obligations

Short- and long-term obligations are as follows:
 
 
July 2,
2016
 
January 2,
2016
(In thousands)
 
 
Revolving Credit Facility, due 2018
 
$
64,315

 
$
26,000

Commercial Real Estate Loan, due 2016
 
—

 
5,250

Total Short- and Long-Term Obligations
 
64,315

 
31,250

Less: Short-Term Obligations and Current Maturities
 
(3,109
)
 
(5,250
)
Long-Term Obligations
 
$
61,206

 
$
26,000


The weighted average interest rate for the Company's short-and long-term obligations was 1.37% as of July 2, 2016.

Revolving Credit Facility
The Company entered into a five-year unsecured revolving credit facility (2012 Credit Agreement) in the aggregate principal amount of up to $100,000,000 on August 3, 2012 and amended it on November 1, 2013 and March 29, 2016. The 2012 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional $50,000,000. The principal on any borrowings made under the 2012 Credit Agreement is due on November 1, 2018. Interest on any loans outstanding under the 2012 Credit Agreement accrues and is payable quarterly in arrears at one of the following rates selected by the Company: (i) the highest of (a) the federal funds rate plus 0.50% plus an applicable margin of 0% to 1%, (b) the prime rate, as defined, plus an applicable margin of 0% to 1% and (c) the Eurocurrency rate, as defined, plus 0.50% plus an applicable margin of 0% to 1% or (ii) the Eurocurrency rate, as defined, plus an applicable margin of 1% to 2%. The applicable margin is determined based upon the ratio of the Company's total debt to earnings before interest, taxes, depreciation, and amortization, as defined in the 2012 Credit Agreement. For this purpose, total debt is defined as total debt less up to $25,000,000 of unrestricted U.S. cash.

The obligations of the Company under the 2012 Credit Agreement may be accelerated upon the occurrence of an event of default under the 2012 Credit Agreement, which includes customary events of default including without limitation payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy- and insolvency-related defaults, defaults relating to such matters as the Employment Retirement Income Security Act, unsatisfied judgments, the failure to pay certain indebtedness, and a change of control default. In addition, the 2012 Credit Agreement contains negative covenants applicable to the Company and its subsidiaries, including financial covenants requiring the Company to comply with a maximum consolidated leverage ratio of 3.5 to 1, a minimum consolidated interest coverage ratio of 3 to 1, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing its fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to the discontinued operation. As of July 2, 2016, the Company was in compliance with these covenants.

Loans under the 2012 Credit Agreement are guaranteed by certain domestic subsidiaries of the Company pursuant to a Guarantee Agreement, effective August 3, 2012.


16

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

6.    Short- and Long-Term Obligations (continued)


The Company borrowed $41,046,000 under the 2012 Credit Agreement in the first quarter of 2016, of which $29,866,000 was a euro-denominated borrowing used to fund the PAAL acquisition, which occurred at the beginning of the second quarter of 2016. As of July 2, 2016, the outstanding balance under the 2012 Credit Agreement was $64,315,000. As of July 2, 2016, the Company had $35,096,000 of borrowing capacity available under the committed portion of its 2012 Credit Agreement. The amount the Company is able to borrow under the 2012 Credit Agreement is the total borrowing capacity of $100,000,000 less any outstanding borrowings, letters of credit and multi-currency borrowings issued under the 2012 Credit Agreement.

Commercial Real Estate Loan
In the first six months of 2016, the Company repaid the outstanding principal balance on the commercial real estate loan.

7.    Stock-Based Compensation

The Company recognized stock-based compensation expense of $1,273,000 and $1,653,000 in the second quarters of 2016 and 2015, respectively, and $2,596,000 and $3,241,000 in the first six months of 2016 and 2015, respectively, within SG&A expenses in the accompanying condensed consolidated statement of income. The Company recognizes compensation cost for all stock-based awards granted to employees and directors based on the grant date estimate of fair value for those awards. The fair value of RSUs is based on the grant date trading price of the Company's common stock, reduced by the present value of estimated dividends foregone during the requisite service period. For time-based RSUs, compensation expense is recognized ratably over the requisite service period for the entire award net of forfeitures. For performance-based RSUs, compensation expense is recognized ratably over the requisite service period for each separately-vesting portion of the award net of forfeitures and remeasured at each reporting period until the total number of RSUs to be issued is known. During the first quarter of 2016, the Company granted stock-based compensation to executive officers and employees consisting of 53,811 shares of performance-based RSUs and 58,438 shares of time-based RSUs and granted 20,000 shares of time-based RSUs to its non-employee directors. Unrecognized compensation expense related to stock-based compensation totaled approximately $6,522,000 at July 2, 2016, and will be recognized over a weighted average period of 1.8 years.

8.    Employee Benefit Plans

The Company sponsors a noncontributory defined benefit retirement plan for the benefit of eligible employees at its Kadant Solutions division and its corporate office (included in the table below under "Pension Benefits"). The Company also sponsors a restoration plan for the benefit of certain executive officers who also participate in the noncontributory defined benefit retirement plan (included in the table below under "Other Benefits"). In addition, employees at certain of the Company's subsidiaries participate in defined benefit retirement and post-retirement welfare benefit plans (included in the table below under "Other Benefits").


17

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

8.    Employee Benefit Plans (continued)


The components of net periodic benefit cost for the pension benefits and other benefits plans are as follows:
 
 
Three Months Ended 
 July 2, 2016
 
Three Months Ended 
 July 4, 2015
(In thousands, except percentages)
 
Pension
Benefits
 
Other
Benefits
 
Pension
Benefits
 
Other
Benefits
Components of Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
Service cost
 
$
181

 
$
60

 
$
211

 
$
55

Interest cost
 
318

 
64

 
307

 
63

Expected return on plan assets
 
(322
)
 
(7
)
 
(356
)
 
(10
)
Recognized net actuarial loss
 
124

 
22

 
127

 
18

Amortization of prior service cost
 
14

 
23

 
14

 
24

Net Periodic Benefit Cost
 
$
315

 
$
162

 
$
303

 
$
150

 
 
 
 
 
 
 
 
 
The weighted average assumptions used to determine net periodic benefit cost are as follows:
 
 

 
 
 
 
 
 
 
 
 
Discount Rate
 
4.22
%
 
4.09
%
 
3.87
%
 
3.75
%
Expected Long-Term Return on Plan Assets
 
5.00
%
 
—

 
5.25
%
 
—

Rate of Compensation Increase
 
3.00
%
 
3.01
%
 
3.00
%
 
2.99
%
 
 
Six Months Ended 
 July 2, 2016
 
Six Months Ended 
 July 4, 2015
(In thousands, except percentages)
 
Pension
Benefits
 
Other
Benefits
 
Pension
Benefits
 
Other
Benefits
Components of Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
Service cost
 
$
362

 
$
118

 
$
422

 
$
112

Interest cost
 
636

 
128

 
614

 
128

Expected return on plan assets
 
(644
)
 
(14
)
 
(712
)
 
(21
)
Recognized net actuarial loss
 
248

 
44

 
254

 
35

Amortization of prior service cost
 
28

 
47

 
28

 
46

Settlement loss
 
—

 
114

 
—

 
—

Net Periodic Benefit Cost
 
$
630

 
$
437

 
$
606

 
$
300

 
 
 
 
 
 
 
 
 
The weighted average assumptions used to determine net periodic benefit cost are as follows:
 
 

 
 
 
 
 
 
 
 
 
Discount Rate
 
4.22
%
 
4.08
%
 
3.87
%
 
3.75
%
Expected Long-Term Return on Plan Assets
 
5.00
%
 
—

 
5.25
%
 
—

Rate of Compensation Increase
 
3.00
%
 
3.01
%
 
3.00
%
 
2.99
%

The Company made cash contributions of $540,000 to its Kadant Solutions division's noncontributory defined benefit retirement plan in the first six months of 2016 and expects to make cash contributions of $540,000 over the remainder of 2016. For the remaining pension and post-retirement welfare benefits plans, the Company does not expect to make any cash contributions other than to fund current benefit payments in 2016.


18

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)




9.    Accumulated Other Comprehensive Items

Comprehensive income combines net income and other comprehensive items, including foreign currency translation adjustments, deferred losses and unrecognized prior service cost associated with pension and other post-retirement plans, and deferred losses on hedging instruments.

Changes in each component of accumulated other comprehensive items (AOCI), net of tax, in the accompanying condensed consolidated balance sheet are as follows:
(In thousands)
 
Foreign
Currency
Translation
Adjustment
 
Unrecognized
Prior Service
Cost
 
Deferred Loss
on Pension and
Other Post-
Retirement
Plans
 
Deferred Loss
on Hedging
Instruments
 
Accumulated
Other
Comprehensive
Items
Balance at January 2, 2016
 
$
(27,932
)
 
$
(489
)
 
$
(8,322
)
 
$
(229
)
 
$
(36,972
)
Other Comprehensive Income (Loss) Before Reclassifications
 
713

 
(1
)
 
(583
)
 
(317
)
 
(188
)
Reclassifications from AOCI
 
—

 
48

 
265

 
277

 
590

Net Current Period Other Comprehensive Income (Loss)
 
713

 
47

 
(318
)
 
(40
)
 
402

Balance at July 2, 2016
 
$
(27,219
)
 
$
(442
)
 
$
(8,640
)
 
$
(269
)
 
$
(36,570
)
 
 
 
 
 
 
 
 
 
 
 
Balance at January 3, 2015
 
$
(7,371
)
 
$
(589
)
 
$
(8,394
)
 
$
(792
)
 
$
(17,146
)
Other Comprehensive (Loss) Income Before Reclassifications
 
(9,732
)
 
3

 
50

 
1,091

 
(8,588
)
Reclassifications from AOCI
 
—

 
47

 
188

 
(1,171
)
 
(936
)
Net Current Period Other Comprehensive (Loss) Income
 
(9,732
)
 
50

 
238

 
(80
)
 
(9,524
)
Balance at July 4, 2015
 
$
(17,103
)
 
$
(539
)
 
$
(8,156
)
 
$
(872
)
 
$
(26,670
)

Amounts reclassified from AOCI are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
Statement of Income
(In thousands)
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
 
Line Item
Pension and Other Post-Retirement Plans: (a)
 
 
 
 
 
 
 
      
Amortization of prior service costs
 
$
(36
)
 
$
(37
)
 
$
(74
)
 
$
(73
)
 
SG&A expenses
Amortization of actuarial losses
 
(146
)
 
(145
)
 
(406
)
 
(289
)
 
SG&A expenses
Total expense before income taxes
 
(182
)
 
(182
)
 
(480
)
 
(362
)
 
 
Income tax benefit
 
63

 
64

 
167

 
127

 
Provision for income taxes
 
 
(119
)
 
(118
)
 
(313
)
 
(235
)
 
 
Cash Flow Hedges: (b)
 
 

 
 

 
 

 
 

 
      
Interest rate swap agreements
 
(47
)
 
(107
)
 
(136
)
 
(211
)
 
Interest expense
Forward currency-exchange contracts
 
37

 
—

 
(24
)
 
—

 
Revenues
Forward currency-exchange contracts
 
(46
)
 
—

 
(69
)
 
—

 
Cost of revenues
Forward currency-exchange contracts
 
—

 
(13
)
 
—

 
1,506

 
SG&A expenses
Total (expense) income before income taxes
 
(56
)
 
(120
)
 
(229
)
 
1,295

 
 
Income tax (provision) benefit
 
(108
)
 
40

 
(48
)
 
(124
)
 
Provision for income taxes
 
 
(164
)
 
(80
)
 
(277
)
 
1,171

 
 
Total Reclassifications
 
$
(283
)
 
$
(198
)
 
$
(590
)
 
$
936

 
 

(a)
Included in the computation of net periodic pension costs. See Note 8 for additional information.
(b)
See Note 10 for additional information.

19

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)




10.    Derivatives

The Company uses derivative instruments primarily to reduce its exposure to changes in currency exchange rates and interest rates. When the Company enters into a derivative contract, the Company makes a determination as to whether the transaction is deemed to be a hedge for accounting purposes. For a contract deemed to be a hedge, the Company formally documents the relationship between the derivative instrument and the risk being hedged. In this documentation, the Company specifically identifies the asset, liability, forecasted transaction, cash flow, or net investment that has been designated as the hedged item, and evaluates whether the derivative instrument is expected to reduce the risks associated with the hedged item. To the extent these criteria are not met, the Company does not use hedge accounting for the derivative. The changes in the fair value of a derivative not deemed to be a hedge are recorded currently in earnings. The Company does not hold or engage in transactions involving derivative instruments for purposes other than risk management.

ASC 815, "Derivatives and Hedging," requires that all derivatives be recognized on the balance sheet at fair value. For derivatives designated as cash flow hedges, the related gains or losses on these contracts are deferred as a component of AOCI. These deferred gains and losses are recognized in the period in which the underlying anticipated transaction occurs. For derivatives designated as fair value hedges, the unrealized gains and losses resulting from the impact of currency exchange rate movements are recognized in earnings in the period in which the exchange rates change and offset the currency gains and losses on the underlying exposures being hedged. The Company performs an evaluation of the effectiveness of the hedge both at inception and on an ongoing basis. The ineffective portion of a hedge, if any, and changes in the fair value of a derivative not deemed to be a hedge are recorded in the condensed consolidated statement of income.

Interest Rate Swap Agreements
On January 16, 2015, the Company entered into a swap agreement (2015 Swap Agreement) to hedge its exposure to movements in the three-month London Inter-Bank Offered Rate (LIBOR) rate on future outstanding debt and has designated the 2015 Swap Agreement as a cash flow hedge. The 2015 Swap Agreement expires on March 27, 2020 and has a $10,000,000 notional value. Under the 2015 Swap Agreement, on a quarterly basis, the Company receives a three-month LIBOR rate and pays a fixed rate of interest of 1.50% plus an applicable margin. The fair value of the 2015 Swap Agreement as of July 2, 2016 is included in other long-term liabilities, with an offset to AOCI (net of tax) in the accompanying condensed consolidated balance sheet.

The Company has structured the 2015 Swap Agreement to be 100% effective, and as a result, there is no current impact to earnings resulting from hedge ineffectiveness. Management believes that any credit risk associated with the 2015 Swap Agreement is remote based on the Company's financial position and the creditworthiness of the financial institution issuing the 2015 Swap Agreement.

The counterparty to the 2015 Swap Agreement could demand an early termination of the 2015 Swap Agreement if the Company is in default under the 2012 Credit Agreement, or any agreement that amends or replaces the 2012 Credit Agreement in which the counterparty is a member, and the Company is unable to cure the default. An event of default under the 2012 Credit Agreement includes customary events of default and failure to comply with financial covenants, including a maximum consolidated leverage ratio of 3.5 to 1, and a minimum consolidated interest coverage ratio of 3 to 1. As of July 2, 2016, the Company was in compliance with these covenants. The unrealized loss associated with the 2015 Swap Agreement was $232,000 as of July 2, 2016, which represents the estimated amount that the Company would pay to the counterparty in the event of an early termination.

The Company entered into a swap agreement in 2006 (2006 Swap Agreement) to convert a portion of the Company's outstanding debt from a floating to a fixed rate of interest. The 2006 Swap Agreement expired in May 2016.

Forward Currency-Exchange Contracts
The Company uses forward currency-exchange contracts primarily to hedge exposures resulting from fluctuations in currency exchange rates. Such exposures result primarily from portions of the Company's operations and assets and liabilities that are denominated in currencies other than the functional currencies of the businesses conducting the operations or holding the assets and liabilities. The Company typically manages its level of exposure to the risk of currency-exchange fluctuations by hedging a portion of its currency exposures anticipated over the ensuing 12-month period, using forward currency-exchange contracts that have maturities of 12 months or less.

20

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

10.    Derivatives (continued)

Forward currency-exchange contracts that hedge forecasted accounts receivable or accounts payable are designated as cash flow hedges. The fair values for these instruments are included in other current assets for unrecognized gains and in other current liabilities for unrecognized losses, with an offset in AOCI (net of tax). For forward currency-exchange contracts that are designated as fair value hedges, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item are recognized currently in earnings. The fair values of forward currency-exchange contracts that are not designated as hedges are recorded currently in earnings.

The Company recognized within SG&A expenses a loss of $225,000 and a gain of $6,000 in the second quarters of 2016 and 2015, respectively, and a loss of $436,000 and a gain of $7,000 in the first six months of 2016 and 2015, respectively, associated with forward currency-exchange contracts that were not designated as hedges. Management believes that any credit risk associated with forward currency-exchange contracts is remote based on the Company's financial position and the creditworthiness of the financial institutions issuing the contracts.

The following table summarizes the fair value of the Company's derivative instruments designated and not designated as hedging instruments, the notional values of the associated derivative contracts, and the location of these instruments in the condensed consolidated balance sheet:
 
 
 
 
July 2, 2016
 
January 2, 2016
 
 
Balance Sheet Location
 
Asset (Liability) (a)
 
Notional Amount (b)
 
Asset (Liability) (a)
 
Notional Amount
(In thousands)
 
 
 
 
 
Derivatives Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
Derivatives in an Asset Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Assets
 
$
9

 
$
1,161

 
$
—

 
$
—

Interest rate swap agreement
 
Other Assets
 
$
—

 
$
—

 
$
38

 
$
10,000

Derivatives in a Liability Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Liabilities
 
$
(195
)
 
$
2,767

 
$
(101
)
 
$
6,525

Interest rate swap agreement
 
Other Current Liabilities
 
$
—